How China’s Reforms Have Altered The Agricultural Landscape

China Farming

To date, most of the focus on China’s financial market liberalization has been on freeing up interest rates and the capital account. But another area where Beijing has signaled its intent to allow market-determined prices is agriculture, where it is pushing through urgently-needed reform to boost the efficiency of domestic food production.

Historically, China’s agricultural sector has been highly controlled as food security takes on another dimension when you have responsibility to feed almost one quarter of the world’s population.

This task has been made more difficult due to China’s limited space, with a similar land mass to the United States but four times the population. It is also short of fertile land to grow crops with only about 14 percent of land arable.  And while the appetite of the population has been steadily growing, at the same time, its farming land resources have been shrinking.

Three decades of double-digit growth has put further pressure on this scarce resource as pollution and water shortages worsen. In December 2013, the government released the results of a land survey, which revealed more than 2 percent of arable land – or an area the size of Belgium – was too polluted to grow crops.

 

Rising Food Prices

Another factor motivating the government to act is it needs to contain food price rises, which are historically politically-sensitive in China. Data from the Economist Intelligence Unit illustrates how food prices have been increasing at a much faster rate in China compared to the U.S. in recent years.

Together, this explains why measures to increase the efficiency of how China feeds itself have taken on a new urgency.

In the past, the approach to achieving food sustainability has focused on preserving land and dispensing generous food production subsidies to encourage adequate production amongst small farmers. China has set a “red line” that arable land never shrinks to below  120 million hectares. Now the government is adopting a multi-pronged approach to boost efficiency in the agricultural sector.

One change is new land reform aimed at enhancing productivity of farmland and boosting the rights of farmers. The changes will allow farmers to trade the rights of their contracted land, while maintaining a policy of collective land ownership. This would give farmers a legal basis for mortgaging their land rights and help encourage development of larger-scale farming entities.  The intent is to boost property income from land so that farmers have greater capacity to invest and improve the efficiency of farming.

But farmers may need this cushion. Other policy reforms to deregulate factor prices could see some of the old price guarantees and subsidies removed.

In November 2013, the head of the rural department of the National Development and Reform Commission was reported to comment that “grain prices have come to the stage to be decided by the market.”

Such a change could have a considerable impact.

China is considering reforming its agricultural support program, which offers minimum state procurement prices for a range of products like wheat, pork and corn.

At the moment the support for corn prices is double the U.S., with wheat not far behind and there is also generous support for sugar.

 

Embracing Modern Agriculture

The impact of a change brings some uncertainty. For one, it is expected to lead to China reducing its extensive stockpiling of commodities. Yet at the same time, we could see greater direct imports.

In January, the release of a draft of the annual agriculture policy review statement, focused on the development of “modern agriculture,” with greater emphasis on the quality rather than just quantity of what is produced.  It also pointed to a move away from a longstanding policy of food self-sufficiency, which has kept the ratio of food crop relative to consumption at 95 percent  by calling for an “appropriate” amount of imports. This can be seen in new guidelines for grain production, which called for output to stabilize at 550 million metric tons by 2020, below the 2013 harvest of 603 million metric tons.

Changes in China’s agricultural policy need to be watched closely due to their potential impact on global prices.  China is the world’s biggest buyer of rice and soya beans, and according to the U.S. Department of Agriculture, is also the second-largest buyer of wheat and fourth-ranked corn importer. The longer-term impact is we would expect China’s domestic prices to converge closer to international prices.

 

Ag Derivatives in China

This will also have implications for the agricultural derivatives business in China. We expect it to be impacted in three significant ways.

First, volatility in Chinese agricultural prices can be expected to rise, which should lead to greater demand for hedging via agricultural futures on domestic Chinese exchanges. The exchanges that stand most to benefit from this would be the likes of Dalian Commodity Exchange (DCE), and Zhengzhou Commodity Exchange (ZCE).

Secondly, as China’s domestic prices begin to approximate international prices, spread trading between domestic futures and international futures becomes appealing as the fundamental price parity relationship is re-established once again. This will benefit CME Group’s agricultural suite of products and the RMB futures contract as traders will need to hedge both their price risks and forex risks respectively.

Thirdly, as agricultural imports grow, Chinese importers will increasingly look to international futures as a hedging tool for managing their import price risks. Imports are still largely transacted in U.S. dollars – the main currency of trade today. By using international futures denominated in USD, Chinese importers can minimize their foreign exchange risk and achieve a cleaner hedge on their books.

With these in mind, derivatives exchanges seeking to capture China’s growth need to make sure they do not neglect agriculture opportunities in the aforementioned three areas.  Chinese participants, likewise will do well to familiarize themselves with these hedging tools in preparation for impending reforms that are just beginning to take shape.

 

Read More:

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About the Author

Nelson Low is Executive Director of Commodity Products, Asia for CME Group.

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